Markets Are Wrestling with a Return to Normalcy

The past few days have seen the stock market fall back hard with the S&P 500 moving from new highs to piercing its 200-day moving average in a shocking 5-day torrent of selling. However, that’s a -7% swing, which used to count for just beyond the halfway mark in a typical pullback. Of course the market over the past few years has been anything but typical, having set records for benign trading in an almost unceasing march upward. This week’s selling looks more like a return to normalcy when viewed on a long-term chart as shown below. (Note the importance of the 20-month moving average – blue line).

Nevertheless, this week’s slide has been sharp and fast, with buyers holding out for lower prices. Here, we see the Nasdaq 100 (QQQ) ripping lower to visit its 200-day moving average (red line), a support line the index blasted through in Thursday’s trading.

That 200-day moving average (also the solid black line below) has been a support line for stocks for well over two years (note arrows where stocks bounce off the 200-day moving average).

What is behind the selling?

If investors were concerned about geopolitical issues, money would be flowing into the safety of Treasury bonds. But that has NOT been the case. See chart below of long-term U.S. Treasury bond prices – down 7% in six weeks.

Nor, despite many headlines suggesting so, are they unduly concerned with interest rates. Here we see that utilities have been holding up as stocks drop. If the market was concerned with interest rates, would investors really be buying fixed-rate utilities? Probably not.

What we expect is that the market is merely making a short-term adjustment in a return to normal monetary policy where cash can earn a 2-3% return, the Federal Reserve is no longer the focus it was during the financial crisis and years following, and market participants go back to considering economics and earnings discounted by normal, non-zero interest rates. History shows that stocks do well as long as 10-year U.S. Treasury rates are below 5%, a point where inflation remains tame. After a near +65% run in the Nasdaq 100 (QQQ) over the past 24 months, it is not really a surprise that some froth is coming out of this market. Normalcy means that investors will likely oversell the market, as they do in typical market corrections, creating opportunities for value investors to step in; opportunities those value investors had almost given up ever seeing again in the high-flying days of the recent past. Normalcy means that it pays to be focused on profiting from both good days and bad days in the market, where just sitting and holding stocks is not the best approach. Normalcy means that TimingCube’s method of investing becomes more critical to being a successful investor.

Market Update

After five months of calm, investors were reminded how fickle the stock market can be this week. Only days after posting record highs, stocks staged a ferocious selloff this week, the first since February’s steep pullback. Contentious words between Chinese and U.S. leaders, and also between Italian and European Union leaders, sent stocks lower Monday. An afternoon reversal pushed the S&P 500 back to flat on the day while the Nasdaq held a -0.7% decline. Tuesday brought the International Monetary Fund (IMF) trimming its economic growth forecast while an earnings warning from global chemical company PPG put definition to vague fears that inflation is ramping while global growth is slowing. The materials sector, leveraged to global growth prospects, slid -3.5%. The broader market, however, held firm with an unchanged day. The cumulative effect of those global growth fears, in no small part helped along by continued trade tariff uncertainty, coupled with the recent spike in interest rates to send stock investors rushing to the sidelines Wednesday. Stocks were ripped apart with the leadership tech/consumer sector bearing the brunt of a vicious wave of selling. The Nasdaq fell -4% on the day with the selling stopped by the closely watched 200-day moving average, a long-term trendline that often brings a flurry of pre-programmed buy orders. But all the trendline did this time around was provide a halt to the selling. Stocks resumed their selling Thursday when an initial rebound effort fizzled in the afternoon. Stock indexes fell below their long-term 200-day trendline and stayed there for the first time since February 2016. With indexes looking very meager, bulls staged another rally effort Friday as bank earnings came into play. The earnings offered mixed results leading a morning market advance to be checked with another round of selling. However, this time, the bulls ultimately carried the day in an afternoon rally that brought indexes back above their 200-day trendlines. The Nasdaq recovered +2.3% while the broader indexes were higher by between +1.0-1.5%.

Friday’s technical recovery back above the 200-day moving average was a small consolation for bullish investors who saw the S&P 500 (SPY) tumble -4.10% for the week. The Nasdaq 100 (QQQ) did a little better trimming its weekly downdraft to -3.24%. Small-cap stocks (IWM) continue to suffer worse than their larger brethren, as they are viewed to be more impacted by higher interest rates. The smaller company stocks slid -5.28% for the week, essentially erasing their year-to-date gains.